By Min Zeng

The U.S. government bond market started November's trading on a down note, sending the yield on the benchmark 10-year Treasury note toward a five-month high.

Investors shed holdings of haven debt after a manufacturing indicator out of China reached the highest in more than two years. The report reduces worries over a sharp slowdown in the world's second-largest economy and adds to a set of encouraging data over the past month that point to some improvement in the global growth outlook.

The yield on the benchmark 10-year Treasury note reached 1.877% earlier Tuesday and recently was 1.860%, according to Tradeweb, compared with 1.834% Monday. Yields rise as bond prices fall.

The yield touched 1.879% during Oct 28's session, the highest intraday level since the end of May.

Tuesday's selling eased after a manufacturing release in the U.S. was a touch below economists' forecast. The monthly manufacturing index from the Institute for Supply Management was 51.9, compared with 52 forecast by economists.

Still, the index stayed in expansionary territory last month after suffering contraction earlier this year. The employment component strengthened, a healthy sign of the labor market.

Traders say the bond market may be vulnerable to price swings as investors gird for several big events.

The Federal Reserve is widely expected to stand pat Wednesday when it finished its two-day policy meeting. Economists and analysts expect the Fed to reiterate its plan to raise interest rates this year. The interest rate futures suggest many investors are positioned for a moderate increase inDecember.

Whether the Fed raises rates in December hinges on how the economy performs. Friday's nonfarm jobs report will be one of the key datapoints. The U.S. presidential election is another event that will shape the bond market's outlook in the near term, say traders.

Bond yields have been rising after a big drop during the summer following the U.K.'s referendum to leave the European Union. The 10-year note's yield rose by 0.23 percentage point in October, the biggest monthly increase since June 2015.

Investors' appetites for long-term government debt in the developed world have been diminishing due to improvement in global economic data, rising inflation expectation, concerns about major central banks' bond buying programs in Japan and Europe reaching a limit and a potential shift into large fiscal stimulus in 2017 that would require rising government debt issuance for funding.

There is a belief that the yield premium in long-term Treasury bonds "had to increase" to reflect the confluence of factors, said Michael Lorizio, senior trader at Manulife Asset Management.

Valuations on long-term government bonds have been getting stretched with yields falling to historic low levels during the third quarter. Buying long-term debt leaves bond investors exposed to large interest rate risks as the value of long-term debt tends to post a bigger drop compared to their short-term peers in response to a given rise in bond yields.

Analysts have warned that bond investors may be prone to abrupt and potentially large capital loss if hedge funds and money managers exit the bond market in droves. Investors remember the taper tantrum episode in 2013 when worries over reduced bond buying from the Federal Reserve spooked investors, caused record outflows from bond funds and sent bond yields sharply higher.

The risk, say analysts, is that higher bond yields may spread and hurt riskier markets.

Treasury bond yields, especially the benchmark 10-year yield, is the bedrock for global financing and the foundation for investors to measure the value from stocks, corporate bonds to emerging-market assets.

Already, investors have been moving out of U.S. exchange-traded funds targeting junk bonds, or lower-rated corporate bonds over the past weeks. Junk bonds have been one of the biggest beneficiaries this year from a global hunt for income.

Some analysts say the 10-year Treasury yield could rise to 2% or above that level if selling picks up momentum. The yield last traded at 2% back in March.

Some traders say a move closer to 2% would attract buying interest as a swift rise in yields would push up mortgage rates and tighten financial conditions, not a good combination for the U.S. economy that is still stuck in a moderate pace.

Despite the rise, Treasury yields remain historically very low. The yield traded at 2.273% at the end of 2015. It traded at 3% in early 2014.

Write to Min Zeng at min.zeng@wsj.com

(END) Dow Jones Newswires

November 01, 2016 11:09 ET (15:09 GMT)

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